Inflation and interest rates

The Inegi published inflation for the first half of November. The data points to an annualized inflation higher than 7%, a level not only outside the parameter of Banco de México’s inflation target rate (of 3% with a margin of plus minus 1%), but it is also outside the range. predicted by most of the specialists, what they expected if not a pronounced fall, at least that it remained above levels close to 6 percent.

As I have pointed out before, the inflation data is worrying because several of the observations in recent months are similar to those of the last inflationary episode linked to gasoline during the previous administration, but others even go back to those observed more than a decade ago and before , when we were still struggling to keep inflation under control after periods of severe economic crisis.

Inflation today has an atypical conjunctural component, which derives from the effects on production and supply chains as a result of the pandemic and, therefore, it is not the typical inflation that occurs when an economy overheats, when it is generally associated with two additional factors: a growth in the occupancy and employment rate and an increase in the level of consumption (which in turn generates pressure on prices).

In the case of Mexico, the latest national occupation and employment survey shows that, in the words of the president of Inegi, “although the employed population as of 2021-Q3 (55.8 million) already exceeded the pre-ndemic level in 2020-Q1 (55 million ), in that period the population of 15+ rose by almost three million; 900,000 people would be required for the employed population to reach the same proportion of the total ”. Likewise, consumption data has not recovered to pre-pandemic levels. The impact on household income makes them spend less.

In this environment, monetary policy measures, which in Mexico tend to be less effective than in other economies in curbing inflation, will additionally face this obstacle. Today in the United States it is even debated whether or not it is convenient for the Federal Reserve to increase the interest rate in the face of inflationary pressures or whether it should wait for a greater recovery in employment to take place.

For our country, there will also be an additional element of pressure on inflation in the short term. Historically, the exchange rate, when it exhibits sustained periods of depreciation, generates additional pressure on prices, by affecting the price of the inputs of many imported goods. This phenomenon, known as exchange rate pass-thru, can fuel inflation beyond what would naturally be expected at the beginning of next year, when due to a change in the basis of comparison, the ratio should return to levels rather close to 4 percent.

In the last hours, the exchange rate has been affected, in addition to the anticipated forecast of the financial markets in the face of potential movements next year in the reference rate in the United States, by a component of internal distrust in Mexico, derived from the uncertainty in the appointments related to the Bank of Mexico that, for many, raises concerns about the autonomy that the Central Bank will sustain in the future.

More uncertainty and an adverse international environment can fuel inflation and make it even more worrisome.

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